More Capital Makes Banks Safer. Discuss

Vince Cable, U.K. business secretary, notoriously dubbed them the “capital Taliban”: members of the Bank of England who called for super-charged capital ratios to rein banks in.

Such name-calling suggests they may have their opponents rattled. And, indeed, many of arguments against raising capital buffers have been comprehensively debunked. Increasing capital buffers reduces lending to the economy? Not true. It makes banks less attractive investment prospects? How come Deutsche Bank’s share price has risen 8% since April 29 when it announced a €2.8 billion ($3.7 billion) rights issue to bolster its regulatory capital?

This proposal echoed a suggestion made by Robert Jenkins, a member of the financial policy committee of the Bank of England, in July last year: “How about a moratorium on all new regulation followed by a review and rollback of the rule book. In exchange, all banks everywhere would be required to raise their tangible equity capital to 20% of assets.”

His logic was that higher capital does not necessarily damage the economy, discourage lending or make banks less appealing investments. But it also accepted that regulations are too numerous and may be misguided: “So,” concluded Jenkins, “the best solution is to set the minimum for loss-absorbing capital at a level that discourages recklessness and protects the public purse when it happens.”

Such suggestions illustrate a belief that capital is some kind of regulatory panacea.

But let’s be clear: increasing a bank’s capital does not, in and of itself, stop a bank getting into trouble. The risk of a bank losing money is wholly dependent on how it conducts itself and to whom it lends money.

And yet the regulatory response to the financial crisis has been predominately focused on capital while almost willfully ignoring the main business of banking.

It is a bit like arguing over the exact thickness of a crash pad without stopping to ask if the tightrope walker knows what he’s doing.

The accepted wisdom is that there is little that the authorities can do to curb bad lending decisions. But increasing transparency would surely help. Force the banks to open their books and provide more information on their assets (and how they are valued) and you introduce much-needed market discipline.

Why isn’t more being done? Well, a disconcertingly high proportion of those loans hidden away on balance sheets – the banks’ assets – are mortgages and government debt. Far better that we all concentrate on the crash mat. That way, we may be too distracted to notice what the tightrope walker has balancing on his shoulders – the developed world’s enormous and ever-expanding household and public-debt burden.